Lure of pension swap could leave employees out of pocket

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Questionable tactics are still used to tempt transfers away from final salary schemes, finds Jeff Salway

PRIVATE sector firms are still using unscrupulous tactics to lure workers out of their final salary pension schemes in a bid to cut costs, industry insiders warn.

Thousands of people have been left out of pocket in retirement after being coerced by their employer into giving up their gold-plated pension benefits.

In many cases members have sacrificed inflation-linked pension increases, even as the cost of living edges up.

And more employees will come under pressure to relinquish their generous pension rights after a record increase in the number of private sector firms closing their final salary schemes.

The decline in the number of firms offering final salary schemes – where the final pension pot depends on earnings and length of service – has gathered pace in recent years as the cost of providing them has soared. The demise of final salary pensions accelerated again in 2012, according to the National Association of Pension Funds (NAPF).

Just 13 per cent of schemes were open to new members last year, it revealed, down from 19 per cent in 2011 and from 43 per cent in 2005.

Employers blame the impact of rising longevity and poor ­investment returns. However a third factor has made matters worse – quantitative easing. By purchasing gilts the Bank of England’s so-called money printing scheme has driven down the returns that pension funds get from those gilts, as well as affecting the way pension liabilities are worked out.

Would-be members of final salary schemes are not the only ones losing out, however. There has also been a sharp ­increase in the number of ­employers closing their schemes to existing members.

Of the schemes still open to existing staff, a third are planning to make changes, including ­closing their scheme or making it less generous, the NAPF found. Joanne Segars, its chief executive, said: “Those starting a new job in the private sector have next to no chance of getting a final salary pension. What was once the norm is now a very rare offer. And those who are currently saving into one may find it gets closed.”

That’s bad news for more than two million people who are saving into final salary schemes. The inducements ­offered to workers are often part of “enhanced transfer ­value” (ETV) deals, which have often featured cash payments in an effort to tempt individuals into giving up their pension rights.

“The incentive will usually take the form of an uplift in their transfer value but may also be in the form of a cash lump sum or a combination of both,” said Steven Dunn, head of pensions at Anderson Strathern in Edinburgh. “I’m uncomfortable with cash sums being used as the incentive and would rather employers enhance transfer values instead.”

The government last year introduced a new code of practice including a ban on cash bribes. Its move followed a warning from the City regulator that employers eager to cut pension liabilities were using unfair means to tempt members out of their schemes.

But ETVs are on the rise regardless. And the latest round of final salary scheme closures could see more firms offering transfer-out incentives to ­employees, according to Colin Richardson, senior corporate consulting actuary at Buck Consultants. “In theory, the increased scheme closures may lead to more ETVs because deferred pensioners are comprising a greater proportion of membership in most schemes. Millions of deferred pensioners are set to be as such for the long term,” he said.

The reason companies want to get people out of their final salary schemes is clear – they are becoming increasingly ­expensive to run. But what’s in it for the employee? After all, they’re giving up a guaranteed retirement income that will rise in line with inflation.

In most cases, employees moved out of final salary ­arrangements are switched into defined contribution schemes, where the outcome depends on the amount contributed, investment performance and (in most cases) annuity rates.

So companies have to provide an attractive incentive for members to leave their final salary scheme. The usual scenario under ETVs is for the pension being transferred to be increased in order to offset the extra risk being taken on by the member.

But firms are adept at ensuring the ETV works out in their favour, on the assumption that the individual will be blinded by the headline incentive. For example, if the member fails to take advice they may not realise they need an investment return of 7 per cent or more to secure the pension benefits that would have been provided by their ­final salary scheme.

Up to three in ten workers accept ETV offers, the NAPF has said, but it’s often far higher. Dunn said: “I have seen some ETVs with a take-up rate approaching 50 per cent. There will be costs in running an ETV and when combined with the actual costs of the enhancement ­itself, an employer needs to consider what level of take-up rate would be required in ­order to make it worthwhile.”

The cost of not doing it is also considerable, however, which is why more workers in final salary schemes can ­expect to be asked if they want to sacrifice their generous ­benefits. It’s sometimes in the member’s interest to do so. They may want more control over their pension investments, for example, or have a health condition or lifestyle that qualifies them for an enhanced annuity.

“These pay out more than conventional annuities, but only rarely is it likely to be higher than the guaranteed income being sacrificed.

The potentially expensive consequences of making the wrong decision when offered an inducement to leave a final salary scheme mean that advice is essential, said Dunn.

“There should be little objection to an exercise which provides a reasonable level of uplift in transfer values, where the employer has fully engaged with the trustees, provided its members with full information and allowed them access to an IFA to determine whether they should accept the offer.

“However, employers should not be too surprised if after all that there’s little or no interest from the scheme members.”

Twitter: @VaughanSalway